ACTIONABLE ADVICE FOR FINANCIAL ADVISORS: Newsletters and Commentaries Focused on Investment Strategy

Ketchup vs Cash

February 19th, 2013

by John Petrides

of Advisors Capital Management

Last week Warren Buffet's Berkshire Hathaway, along with 3G Capital, bought Heinz (ticker HNZ) for $28 billion, paying a 20% premium to the prior trading day's closing price (as well as Buffet rewarding himself with preferred stock yielding 9%). Heinz is a mature company trying to reestablish growth by selling ketchup and other condiments in developing countries. However, Heinz is a classic "steady-eddy." It is a slow growing company, with stable cash flow, consisting of a management team that has a solid history of returning cash to shareholders through dividends and share buybacks. Heinz is not flashy. It's not headline making. It's classic Buffet! However, investors, especially those who are overweight cash, and feel paralyzed by the recent market run up, need to look deeper at the intention of the deal.

In buying Heinz, Buffet would rather own boring, stable, steady cash flow generating companies than sit on pure cash. Heinz isn't going to go out of business if there is a sovereign debt crisis in Europe, or if Congress does not raise the debt ceiling. Nor will it go out of business if a military conflict ensues between Israel and Iran (reader can insert most other risks scaring investors out of the market today that HNZ could prosper through). Buffet bought Heinz because of its incredible brand recognition, simple business model, and its ability to continually raise pricing on its products (the 9% yield on the preferred stock is "gravy"). Buffet knows that through Heinz he can outperform the 0% return he is currently earning on his cash.

Heinz is not a typical "value" play in the sense of a company trading at a low price-to-earnings multiple. In fact, it consistently trades at a premium to other Consumer Staples stocks and the S&P 500, in large part because of its stability. Over the past five years, HNZ has grown its sales 5%, mainly on price increases. It has grown earnings per share 6% and its dividend per share7.5% annually over the same time frame. Prior to the deal, HNZ had a ~3.5% dividend yield. On the surface there is nothing exciting about Heinz, especially when paying 20% above its historic high price, but when you compare its potential returns to cash and/or bonds, it is an easy investment decision to make.

ACM's Growth with Income strategy has a number of "Heinz-like" companies in it. Although it doesn't own HNZ currently, the strategy does own other companies with similar characteristics of consistency. Since its inception in 1999, the financial objectives of the strategy continue to be to align those investors seeking capital appreciation first and income second by investing in companies with strong business models, a good track record of returning cash to shareholders, which trade at a discount to our estimated price target. If you would like to learn more about ACM's Growth with Income strategy, please feel free to contact us.

*Full disclosure, ACM does not own any shares of HNZ across any of its products.

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